Financial management -- Chapter 12

leverage and capital structure
terms

Leverage -- results from the use of fixed cost assets or funds to magnify returns to the firm's owners
capital structure -- the mix of long-term debt and equity maintained by the firm
breakeven analysis -- indicates the level of operations necessary to cover all costs and the profitability associated with various levels of sales
operating breakeven point -- the level of sales necessary to cover all operating costs
operating leverage -- the potential use of fixed operating costs to magnify the effects of changes in sales on the firm's earnings before interest and taxes
degree of operating leverage (DOL) -- the numerical measure of the firms operating leverage
financial leverage -- the potential use of fixed financial costs to magnify the effects of changes in earnings before interest and taxes on the firms earnings per share
degree of financial leverage (DFL) -- the numerical measure of the firm's financial leverage
total leverage -- the potential use of fixed costs, both operating and financial, to magnify the effects of changes in sales on the firms earning per share
degree of total leverage (DTL) -- the numerical measure of the firms total leverage
pecking order -- a hierarchy of financing that begins with retained earnings, which is followed by debt financing and finally external equity financing
asymmetric information -- the situation in which managers of a firm have more information about operations and future prospects than do investors
signal -- a financing action by management that is believed to reflect its view of the firms stock value; generally, debt financing is viewed as a positive signal that management believes the stock is "undervalued," and a stock issue is viewed as a negative signal that management believes the stock is "overvalued"
optimal capital structure -- the capital structure at which the weighted average cost of capital is minimized, thereby maximizing the firm's value
EBIT-EPS approach -- an approach for selecting the capital structure that maximizes earnings per share (EPS) over the expected range of earnings before interest and taxes (EBIT)
financial breakeven point -- the level of EBIT necessary to just cover all fixed financial costs